There are a lot of ways to save money on taxes, but only a few that actually result in meaningful savings. In this video, I'm going to review four strategies that will likely have the biggest impact on your tax bill. Let's get into it.
Welcome back to another video from One-Up Financial. I am your host Eric Presogna, CPA and Certified Financial Planner here to help you increase your income, reduce your taxes and invest smarter in retirement.
I thought about on putting together a video discussing the many ways investors can save on taxes, similar to what a lot of other financial institutions in the country are doing around this time.
But the more I thought about it, and after reading through some other tax-tip-related content I realized that sometimes, less is more.
Yes, there are A LOT of things you can do to save money on taxes like getting the above-the-line charitable deduction of $600 or contributing to a traditional IRA.
But when you really break them all down, only a few strategies have the potential to significantly improve your tax situation.
I liken it to a common piece of personal finance advice I hear from the Suzy Ormans of the world. To paraphrase, the advice is as follow: "if you cut out expensive coffee and lattes from your budget and invest that savings each week, you'll have $300,000 in 60 years."
The problem with this advice, other than the fact most people will be dead in 60 years, is that the monetary impact of drinking a Folgers breakfast blend over a Starbucks caramel frappuccino is minimal at best; a blip on your financial radar.
Contrast the coffee savings advice with this less common personal finance strategy which involves "learning how to successfully negotiate a higher salary." This is something personal finance expert and best-selling author Ramit Sethi talks a lot about and if done right, can have a substantial effect on your future earning potential.
Which of the two strategies do you think will create more wealth over time?
I think the answer is pretty obvious.
To bring this all back to taxes, the focus of this video is going to be on those tax tips that REALLY matter. The ones that can save you thousands of dollars as opposed to a few hundred.
Before I begin, the information I cover may have income-limitations, applies to 2022 and should NOT be construed as tax advice. Please consult your tax or financial professional before carrying out any of the strategies discussed in this video.
1. Maximize Pre-Tax Company Retirement Accounts
I know, this may sound like obvious, stock financial advice and you're ready to move on to the next video, but hear me out.
The average 401k participant savings rate in 2021 was 13.9%. Assuming a salary of $100,000, the average employee is contributing $13,900 to their retirement plan. Not a small amount to save each year by any means.
But with the current maximum pre-tax employee contribution amount of $20,500 + a $6,500 catch-up if you're over 50, this average saver is leaving a lot of money on the table!
If the employee instead decided to maximize their 401k, was over the age of 50 and had a marginal tax rate of 20%, those additional retirement contributions would result in a tax savings of approximately $2,600.
Now, some other company retirement plans and contribution limits you may want to pay attention to for 2022 are as follows:
SEP IRA - $61,000
Solo 401k - $61,000
Simple IRA - $14,000 + $3,000 catch-up x 2 for spouse - $34,000
Note, these amounts will be increasing in 2023 so stay tuned for more tax strategies to come in future videos next year!
2. Offset Income AND Capital Gains With Losses
Unfortunately, the IRS limits the amount of realized investment losses that can offset ordinary income to $3,000 per year.
What some investors miss is the fact that losses can offset 100% of realized investment gains.
The easiest way to illustrate this is with an example:
Assume Gary Gains has a legacy stock position in Apple that he purchased several years ago for $50,000 and now, it's worth $250,000. If he sells, Gary will have to report $200,000 in long-term capital gains on his tax return which will result in an additional tax bill of $30,000 (assuming a 15% long-term capital gain rate).
Being the diversified investor Gary is, he also has dipped his toes into a handful of globally diversified ETFs that he purchased for $250,000 and are now, only worth $200,000.
If Gary harvests the $50,000 in losses, he'll only be able to deduct $3,000 on his return this year with the remaining $47,000 being carried forward to future years.
But what Gary COULD do is sell approximately $62,500 of Apple stock and realize $50,000 in gains so that he'll be able to use all of the $50,000 in harvested losses as an offset. This, in-turn saves Gary $7,500 in taxes AND reduce his exposure to Apple.
Using investment losses to offset ordinary income AND capital gains can lead to more tax savings than you may think.
3. Take Advantage of Tax Credits
A tax credit is a dollar for dollar reduction in your tax bill and far more valuable than a deduction.
So it's important to pay attention to any tax credits you may qualify for. Here are four to keep on your radar:
1) The first is the home energy tax credit which applies if you've made qualifying energy-efficient improvements to your home. The maximum tax credit allowable is $500; income limits apply.
2) The second is the child adoption credit which amounts to $14,890 per eligible child; income limits apply.
3) Next is the electric vehicle or EV credit for qualifying all-electric and plug-in hybrid car purchases. The maximum credit (depending on make and model) for 2022 is $7,500.
4) Last but not least is the American Opportunity Tax Credit available for college tuition costs for students in their first 4 years of study. The maximum credit for 2022 is $2,500 for each qualifying student.
To put this all into perspective, a married couple with a tax liability of $26,000 who made enough energy efficient improvements in 2022 to max the allowable credit, adopted a child eligible for the adoption credit, purchased a 2022 RAV4 Prime Plug-In Hybrid, paid first year's tuition for their daughter to attend Penn State and stayed within the income limits for credit purposes would see their tax bill reduced to zero!
Now you may not qualify for all of these tax credits, but even if one or two apply, that could end up saving you thousands in taxes.
4. Bunch Tax Deductions
With the passing of the Tax Cuts and Jobs Act in 2017, most folks who were accustomed to itemizing their taxes have since been forced to take the standard deduction (which has nearly doubled) given limitations imposed on deductions for state and local taxes.
But behold, there is a workaround if you're willing to take some heat from your local taxing authorities!
True story: Back in 2017 when I heard about the changes coming to the tax code, I knew that my real estate taxes would no longer be deductible in 2018. So I took the liberty of prepaying my 2018 taxes in 2017 to get the most out of my tax dollars.
The only downside of this strategy was a nasty phone call I received from the county clerk's office telling me I shouldn't do this anymore as it's difficult for them to account for prepayments. I apologized, hung up the phone and later collected a generous refund on my 1040!
Prepaying real estate taxes is one option for which investors can lump tax deductions in one year to optimize their tax savings.
Another is charitable donations.
If you're used to donating a set amount to charities each year, you may decide to instead make a large donation all at once to what's called a Donor-Advised Fund.
A Donor-Advised Fund is an account setup to allow donors the ability to make charitable contributions to an investment account, receive an instant tax deduction and later determine when and where their dollars are to be donated.
Example: If Joe and Jane Smith typically donate $5,000 each year to various charities, they may not be able to deduct this amount on their taxes if their total itemized deductions are less than the standard deduction of $25,900 (SALT limited to $10,000 mind you). If, however the Smiths decided to lump 5 years' worth of donations into one (assuming they have the funds) and contribute $25,000 to a Donor-Advised Fund, they'll likely receive a hefty tax benefit come April 15th.
Closing
Do any of the strategies discussed in the video apply to you? Are you looking for ways to save more money on taxes? If so, please feel free to give me a call or shoot me an email. I will respond to you personally.
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